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Review 2Q 2010

China’s property market is beginning a “collapse” that will hit the nation’s banking system, said Kenneth Rogoff, the Harvard University professor and former chief economist of the International Monetary Fund.

In a quarter that has been dominated by a UK election outcome, the fate of the Euro, the notion that there may be a ‘double-dip’ after all, the BP (beach polluter) Gulf of Mexico saga and China’s depegging of the Yuan the current call by Rogoff suggesting that the biggest problem facing global markets may be the Chinese banks exposure to Chinese property is arguably the final piece of the ‘juggernaut scenario’ that I highlighted in my previous review. Chinese property prices rose +12.4% in 1H2010 on a reduction of -25% in sales whilst Standard Chartered predict a -30% price correction for 2H2010 to follow the stock market correction to date of -25.6% 1H2010.

Furthermore Mark Mobius, the Emerging Markets (Templeton EM) guru suggested recently that the $600trillion exposure in global derivatives presented a systemic danger to markets and banks especially which again does not bode well for China & EM’s for the forseeable future. The global bailout program started in 2008/9 has failed to stimulate bank lending that has recently tailed off badly (US bank losses have reached $703bn versus a stress-test prediction of $1.1.trillion). The stark contrast between US (where around 200 banks have failed) and UK does not look good either; the US banks appear to be two-thirds down the road whereas UK support has left the sector with nowhere to turn with 12% reduction in UK bank loans since Oct 2008.

The first major test for Cameron & Clegg’s Cons/Lib Coalition without doubt must be how to protect UK pension funds and investors from the onslaught from Obama as a result of BP’s oil spill following the explosion on the TransOcean rig. Admittedly the emergency budget predictably kept markets on an even keel with CGT shifting to 28% and plenty of scope for public sector spending cuts but now BP poses a more serious problem for any UK recovery. In essence I believe that the fall in the share price has been grossly overdone as estimates for the clean-up, repair and damages for local southern businesses (many of whom didn’t get the promised aid after Katrina) as well as penalties incurred rise to $30bn-$300bn estimates (mostly from the US). Looking at Piper Alpha (today is the 22nd anniversary of the fatal rig explosion in the North Sea) and the Exxon Valdez disasters it would appear that the top-end estimates are a little over-stretched and after insurance/reinsurance as well as a fairer sharing of blame (TransOcean, Anardarko,etc) the cost to BP could be less than $30bn. Suffice to suggest that there are a few of us who are concerned at the lack of fiduciary duty shown by BP directors in effectively giving the US authorities an open cheque book for $20bn; anyway to date the costs have amalgamated to $3.1bn so the suspension of the dividend for 2010 is arguably prudent as the market awaits asset sales and possibly equity and bond fund-raisings. I’m of the view that UK government should intervene here and pump say £20bn into BP rather than see dilution via other sovereign funds (Kuwait, China & Singapore have been mentioned). It’s an ongoing scenario but doesn’t deflect the fact that oil stocks (majors & explorers) are arguably cheap on a 2 year + view. The approach for Dana Petroleum by the Koreans (Dana rose c.20% on the initial approach) has highlighted the hidden value across the whole global sector regardless of extra compliance burdens. Nomura suggests that one of the side effects of the oil spill in the Gulf of Mexico “may be that companies have a higher risk appetite for non-US assets.” Hence my commitment to Heritage, Dana, Hardy and Tullow which ostensibly are outside the clutches of Obama who clearly is on some type of crusade with BP.

With constant debates about the state of economies and markets one stable story has been ‘Gold’ against the threat to the Euro, $ despite the relatively low global inflation rates. The age of deflation may well be nearing an end so I’m still actively bullish on gold shares and think that an overweight strategy in precious metals and oils should be maintained. One star amongst global equities is Apple Inc. with the recent launches of its iPad and new iPhone4 with its applications (known as ‘apps’) such as Pandora (effectively a personalised online radio station only open to US users for the time being). The Apple fight with Google’s competitor the ‘Nexus One Android’ should be interesting hereon!

I continue to hold BP despite its problems and Royal Dutch Shell ‘B’ (safe dividend), and miners Yamana Gold, African Barrick (now in FTSE100), Randgold (although the p/e is very high), Petropavlovsk (the former Peter Hambro), Newmont Mining and ASA (US listed closed-end fund focusing on precious metals) buying them on the dips. UK equities such as BAE Systems, British Land, GlaxoSmithKline, Sainsbury , Greene King, Standard Life, Foreign & Colonial Asset and Tullett Prebon can still be bought whilst Dana below 1450p, Heritage Oil, Hardy Oil, etc appear attractive for appreciation in the oil sector. Ashmore Global Opportunities Trust is an interesting play on sovereign and corporate debt and the company has been buying in its own stock to close the discount gap to net asset value. I am still very cautious on the equity market generally as I see valuations and expectations being too high and bullish. A dead cross on FTSE100 is in place and several chartists predict a test to 4,000 and much lower; I wouldn’t want to bet against their expertise as I see little that’s good value other than those stocks previously mentioned.